The US Securities and Exchange Commission has released an investigative report concluding that tokens offered by The DAO constitute securities under federal law, establishing important regulatory precedent for initial coin offerings.
The US Securities and Exchange Commission has concluded that tokens issued by The DAO constitute investment contracts and therefore qualify as securities under federal law. The agency's investigative report declared that DAO token investors had purchased securities without proper registration, violating federal securities statutes.
The SEC determined that DAO tokens met the Howey test for investment contracts. Investors had contributed capital in exchange for potential profits derived from managerial efforts of DAO developers and token holders. This classic securities arrangement meant The DAO required SEC registration or an applicable exemption before conducting its token sale.
The investigation focused on a 2016 token sale that raised approximately twelve million ether, valued at roughly $150 million at that time. The DAO represented an early attempt to create a decentralized venture fund where token holders could vote on investment decisions. The structure proved novel but ultimately flawed when a vulnerability in the smart contract code enabled theft of approximately one-third of the funds.
Importantly, the SEC decided not to pursue enforcement action against The DAO, its developers, or exchanges facilitating secondary token trading. The agency's lenient approach reflected recognition that novel technologies deserved some accommodation as regulators developed appropriate frameworks. However, the SEC clearly stated that future unregistered token offerings could face enforcement proceedings.
The DAO report created substantial uncertainty across the cryptocurrency industry. If DAO tokens were securities, then the vast majority of ICOs conducted in 2017 likely were also unregistered securities offerings. The implications suggested potential liability for token issuers and investors participating in unregistered sales.
Many ICO projects responded by claiming their tokens were utility tokens rather than securities. These projects argued their tokens functioned as currency or access keys for network services rather than investment vehicles promising profits. The distinction proved difficult to establish, as most tokens possessed both utility and investment characteristics.
The SEC's DAO report established important legal precedent shaping ICO regulation for years to come. Regulators had signalled that tokens with investment characteristics would be treated as securities regardless of their technical properties or promotional descriptions. This clarity, while unwelcome to many in the industry, provided a legal framework for responsible token design going forward.
